At What Level Will Saudi Arabia And Russia Stop Pushing Oil Prices Higher?

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Yves here. It’s easy to disagree with some of Simon Watkins’ framing, but he has excellent oil industry contacts and provided useful intel. One bit of background is that oil prices sustained at much above $100 a barrel are believed to be self-correcting due to their impact on demand, and that may be even truer now given the level of the dollar against many currencies. But note that Watkins is not anticipating price increases even to that magic number.

Two possible issues. One is that Watkins argues for the necessity of higher oil prices for Russia and the Saudis, pegging the Saudi “fiscal breakeven” at $78 a barrel. I can’t verify this take but it may well be correct. However, Russia’s economy is much more diversified than most outsiders presume, but it has elected to make oil and gas proceeds the centerpiece of its federal revenues.

By Simon Watkins, a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for Credit Lyonnais, and later Director of Forex at Bank of Montreal. He was then Head of Weekly Publications and Chief Writer for Business Monitor International, Head of Fuel Oil Products for Platts, and Global Managing Editor of Research for Renaissance Capital in Moscow. He has written extensively on oil and gas, Forex, equities, bonds, economics and geopolitics for many leading publications, and has worked as a geopolitical risk consultant for a number of major hedge funds in London, Moscow, and Dubai. Originally published at OilPrice

  • The OPEC+ decision to cut production has added to the inflationary pressure threatening the economic health of the U.S. and many countries allied to it.
  • China’s willingness to tacitly encourage escalating oil and gas prices is likely to be outweighed over time by the indirect impact of that on its economy.
  • The short-term steady equilibrium price for Brent looks to be around US$80-85 pb, with a ceiling of around US$95 pb.

The decisions last week by Saudi Arabia to continue its 1 million barrel per day (bpd) production cut to the end of this year and by Russia to extend its 300,000 barrels per day export cut for the same period conspired to push oil prices to their highest level since last November. This in turn has added to the inflationary pressure threatening the economic health of the U.S. and many countries allied to it. The question for these net oil importers (and gas importers too, given that historically 70 percent of gas prices have been comprised of the price of oil) is at what level the two leaders of OPEC+ will halt their efforts to keep pushing prices higher?

The first part of this equation revolves around the necessity or not of higher prices to keep these two economies afloat, or whether it is simply greed at work, or a geopolitical power play, or any combination thereof. It is a common conception that Saudi Arabia’s economy is a powerhouse, fuelled by vast revenues from oil. The latter part has some truth to it, helped by having (along with Iran and Iraq) the lowest lifting cost per barrel of oil in the world, at just US$1-2. This said, much of these revenues are deducted almost at source, through the massive dividend repayment obligations that must be made every quarter by Saudi Aramco. Even with Brent oil price averaging around US$80 pb in Q2, 65 percent of its net income went on this debt payment to shareholders. If its net income stayed the same in Q3, this debt payment would rise to 98 percent. What is left after these deductions is the foundation stone of all Saudi Arabia’s spending, which includes not just the basic functions of state – such as health, education, and defence – but vast socioeconomic and vanity projects as well, as analysed in depth in my new book on the new global oil market order.

In theory, then, Saudi Arabia’s fiscal breakeven oil price is US$78 pb of Brent. In practice, however – as the fiscal breakeven oil price is the minimum price per barrel that an oil-exporting country needs to meet its expected spending needs while balancing its official budget – its true fiscal breakeven oil price has no set limit. The same applies to Russia. For around 20 years, it had a fiscal breakeven oil price of around US$40 pb. Following its invasion of Ukraine on 24 February 2022, though, officially this has jumped to US$115 pb. Unofficially, as wars do not adhere to easily quantifiable and strictly adhered to budgets, the unofficial fiscal breakeven oil price is whatever President Vladimir Putin thinks it should be at any given moment.

The first part of the equation, then, is that both Saudi Arabia and Russia absolutely need to keep pushing oil prices higher, which moves the equation into its second part – at what level will they face overwhelming pressure from their customers to stop doing so?

The first group of customers are the U.S. and its core allies, in which ever-increasing oil and gas prices have caused dramatic spikes in inflation and the interest rates required to combat it, which in turn make economic recessions more likely. For the U.S. itself, these fears have very specific ramifications: one economic and one political, as also analysed in my new book on the new global oil market order. The economic one is that historically every US$10 pb change in the price of crude oil results in a 25-30 cent change in the price of a gallon of gasoline. For every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion per year in consumer spending is lost, and the U.S. economy suffers. The political one is that, according to statistics from the U.S.’s National Bureau of Economic Research, since the end of World War I in 2018, the sitting U.S. president has won re-election 11 times out of 11 if the U.S. economy was not in recession within two years of an upcoming election. However, sitting U.S. presidents who went into a re-election campaign with the economy in recession won only one time out of seven. This is not a position sitting President Joe Biden, or the Democratic Party, wants to be in one year out from the next U.S. election.

Russia has increasingly less to do with these countries than Saudi Arabia, given the ongoing escalation of sanctions against its energy exports to them. Saudi Arabia has moved so far into China’s sphere of influence now that it appears not to care at all what the U.S. wants in any respect. This was perhaps most personally and palpably underlined when Saudi Crown Prince Mohammed bin Salman refused even to take a telephone call from U.S. President Joe Biden just after Russia’s invasion of Ukraine in which he wanted to ask Saudi Arabia for help to bring down economically-crippling energy prices.

However, this does not mean that the U.S. is powerless to cause Saudi Arabia to change its mind. The mechanism to cut off much of its oil revenues by effectively destroying Saudi Aramco is already in place in the U.S, in the form of the ‘No Oil Producing and Exporting Cartels’ (NOPEC) bill, as also analysed in depth in my new book. This legislation would open the way for sovereign governments to be sued for predatory pricing and any failure to comply with the U.S.’s antitrust laws. OPEC is a de facto cartel, Saudi Arabia is its de facto leader, and Saudi Aramco is Saudi Arabia’s key oil company. The enactment of NOPEC would mean that trading in all Saudi Aramco’s products – including oil – would be subject to the antitrust legislation, meaning the prohibition of sales in U.S. dollars. It would also mean the eventual break-up of Aramco into smaller constituent companies that are not capable of influencing the oil price.

This leaves the big Asian customers, especially China and India. China can purchase oil from several major sources – including Iran, Iraq, Russia, and even Saudi Arabia itself, among many others – at discounts of anywhere from 25 to 45 percent, according to several sources exclusively spoken to by in the past few weeks.

However, China’s willingness to tacitly encourage escalating oil and gas prices is likely to be outweighed over time by the indirect impact of that on its economy. Specifically, it is still highly dependent on exports to the U.S. and its allies, so as rising oil and gas prices hit these economies further, China’s economy will slip further into the mire. As has been seen since the end of 2022, the country’s economic bounce back after three years of very-tightly managed Covid has been less than assured, and could be seen as being at a dangerous tipping point for President Xi Jinping’s government. Its decision on 15 August to stop publishing youth unemployment data after it hit a record 21.3 percent in June will not change the growing discontent in that section of its society. And the government knows that just before the series of violent uprisings in 2010 that marked the onset of the Arab Spring, average youth unemployment across those countries was 23.4 percent. So, either China does not influence Saudi Arabia and Russia towards moderating oil and gas price rises, which will reduce major demand for its exports, which will weigh further on its economy, which will reduce oil and gas demand, which will serve to dampen prices. Or it does, and prices fall by dint of that.

Given this range of factors, the short-term steady equilibrium price for Brent looks to be around US$80-85 pb, with a ceiling of around US$95 pb. Longer-term, these factors should result in a reversion back down to the longstanding ‘Trump Range’ of oil pricing, as also analysed in depth in my new book. The range comprised a Brent price of US$40-45 pb on the floor (the price at which U.S. shale oil producers can survive and make decent profits) to US$75-80 pb on the ceiling (the price after which economic threat becomes apparent to the U.S. and its allies, and political threat looms for sitting U.S. presidents). This range was rigorously enforced under former President Donald Trump’s administration, to the degree that during his entire presidency it was breached only once – for a period of around three weeks (toward the end of September 2018 to the middle of that October).

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  1. Lex

    I’ll admit that the economics discussed and the details of the global oil market are beyond my technical understanding. But some of this sounds borderline made up for the purposes of politics. First, Urals always sells at a discount to the Brent benchmark so I’m confused by the claim that Russia’s actual break even point is $115 pb. That would suggest that Russia has been losing money on oil for pretty much forever. (Even if he’s using the Brent price, the statement seems to defy common sense. Though I suppose that’s a feature of high level economics.)

    And LOL to NOPEC. At the current juncture of international politics the idea of telling everyone “you can’t use dollars for oil transactions” and “we’re suing you so we can confiscate all the reserves you hold in US institutions and break up your oil companies” might be the greatest self destruction in history. It sounds exactly like what US politicians would decide is a fool proof plan.

    Perhaps one of NC’s commenters with better economic chops can give us a hypothetical result of NOPEC being enacted.

    1. Carolinian

      Certainly it’s above my pay grade but re

      The enactment of NOPEC would mean that trading in all Saudi Aramco’s products – including oil – would be subject to the antitrust legislation, meaning the prohibition of sales in U.S. dollars.

      Isn’t the end of the petrodollar the very thing we’ve been trying to avoid all these years? If US policy is for the hegemon to sanction the world then what if the world decides it needs us a lot less than we (and the author of the above article) think it does.

      We already have the hubris. US nemesis soon? Watkins seems worried that Biden may not be re-elected. The rest of us worry that he will be.

      1. ISL

        Worse, he provides zero evidence that if NOPEC is enacted, Saudi Arabia would comply by breaking up Aramco? More likely it would organize an embargo of the US and the West within Opec, sell at Fixed price to China, and watch oil hit 200-250 a barrel and the US economy scream and NOPEC get canceled or WW3 starts. Where do I get 200-250 a barrel? Well, that was the number experts were saying when they worried about Iran shutting down S Arabian oil exports.

    2. Polar Socialist

      The break even price is often based on complicated calculations and guesstimates. It’s not really meant for making statements about national economies but for comparing oil companies from the investors point of view.

      Russian crude extraction costs between $10-$50/barrel depending on the oil field, the average being $15/barrel. The break even point then includes taxes, transportation costs, investments, interests, overheads etc.

      Since Russia is actually using rubles to extract the oil and can adjust the tax rate, a break even price calculated in dollars is very, very rudimentary metrics and doesn’t necessarily reflect what it is though to reflect.

      At least that is my understanding. Even I don’t have much confidence in it.

    3. OnceWere

      I believe he’s using a bespoke definition of “break even point” – not the price necessary to make a profit on a barrel of oil – but the price necessary to prevent the Russian federal budget running a deficit – obviously a much higher figure.

    4. Louis

      What’s the catch with NOPEC bill? i thought the petrodollar was key in keeping the dollar afloat, and the author implies that the bill prohibits petrodollar!

  2. Louis Fyne

    —- China’s willingness to tacitly encourage escalating oil and gas prices is likely to be outweighed over time by the indirect impact of that on its economy—

    The speed with which China is adopting electric vehicles/non-hydrocarbon electricity is pretty gobsmacking—-when the stereotype is that China is still an “emerging” economy in a league before the EU-US.

    Do not be surprised if China is more resilient to “higher for longer” hydrocarbon prices than trans-Atlantic pundits presume.

  3. Revenant

    This article is confused and confusing. In particular, the author conflates Aramco and Saudi Arabia and equity and debt.

    Aramco’s dividend obligations to shareholders are unlikely to be a debt, unless they are a fixed preference dividend. Any additional performance-related dividend is very unlikely to have been structured as a debt, given it is performance-related. Even if they are a debt, they are paid 95% to “Saudi Arabia” (who knows who owns what percentage of the Aramco equity under the hood, we’ll just call it Saudi Arabia but it could be the royal family). So:

    1) even if these are debt obligations, the “break-even” price is the break-even price for Aramco, not Saudi Arabia.
    2) in this confusion, the statement that Aramco payment obligations may consume 98% of Q3 net income (profits) is unparseable: if the payments are a debt, net income is after their payment and they therefore consume 0% of net income; if the payments are a dividend, they may consume 98% of profits but Saudi Arabia would have extracted those profits anyway one way or another to fund its spending
    3) Either way, Saudi Arabia will receive the dividend payments. Even if they fall below the “break-even” price for Aramco, the Saudi budget may still be met because no information is provided on the Saudi Arabian fiscal position.

    1. ISL

      I agree, after reading it, I felt it muddied the waters, and as I have read some of his pieces here before that seem well written, he clearly is trying to muddy the water.

      For example, Saudi Arabia can simply pay its obligations to its citizens in Rials, which it prints, like every other country on the planet – deficit spend – and with 1$ draw cost, Saudi Aramco will be profitable.

      A few years ago, break even for Russia was 60 bucks. Perhaps Watkins is simply adjusting for exchange rate and does not understand the concept of an autarchic economy. Russia does not use dollars to buy Euro-stuff, so it would be the oil cost in rubles to meet Russian budgetary needs in rubles.

    2. Jed

      Thank you. I couldn’t get past that equity/debt issue and quit reading.

      Skipped to comments hoping to find someone mention that.

  4. The Rev Kev

    Could it be that both Russia and China want to keep oil prices high to put constant pressure on the Biden regime? They know that the US Strategic oil Reserve has never been so low and Biden himself is facing an uphill election. They may not be looking for a quick success but by having oil prices this high, it would be creating constant problems for the US and the EU which would pile up over time. Eventually the Biden regime might be willing to negotiate to get prices back down before the election gets too close.

  5. JonnyJames

    Then again, high crude prices are good for the subsidized shale oil/fracked oil producers in the US, which have higher input costs. And BigOil is making obscene price-gouging profits. The “elections” probably have little to do with it, as it does not matter who will become next puppet emperor, the interests of the oligarchy will be served.

    Also, if Venezuela (largest proven reserves) was producing at full, or near full capacity – I am sure prices would drop significantly. If the “sanctions” were lifted on Venezuela, Iran, etc. prices would likely plummet.

    US foreign policy seems to be artificially creating conditions for price-gouging. The oil racket is a notorious tax-dodging, subsidized oligopoly. No matter, they have a win-win, and we get gouged.

  6. Divadab

    High oil prices should reduce demand and therefore carbon emissions. Also may produce more effective gilets jaunes revolts. Plus my 401k’s only bright spot is O&G – both price and dividends.

  7. ilsm

    I read Watkins on occasion. Been doing for several years.

    I follow his fact, less so his inference.

    He reports large investment decisions, which I follow as trend for future capacity.

    Getting in to how much KSA or Russia “need” for budget is too vague for me to follow with Watkins.

    That said as having been a consumer in 1973, I do not discount the potential of crude as economic weapon unrelated to sovereign budget needs.

    USA crude oil trends and net exports of product are “interesting”.

  8. john

    Rising oil prices boost demand for the dollar in exchange, making it easier for USers to buy cheap stuff, while potentially disrupting other economies. This could be the briar patch for the USA, so one wonders why Russia and the Saudis would encourage higher prices.

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